India’s Department of Industrial Policy and Promotion issued Press Note 2 of 2018 (the Press Note) on December 26, 2018, amending the applicable conditions for foreign direct investment (FDI) in the Indian ecommerce sector (the FDI Policy).
These changes, widely considered to be populist measures in an election year in India, have caught some of the international online marketplace giants off guard, which have since delayed their investments resulting in deferred business and growth plans while clarity about the new policy changes are sought.
Under the current FDI Policy, without the amending conditions, 100% FDI is permitted under the automatic route (i.e., without requiring prior government approval) in entities that carry out ecommerce under the “marketplace” model, and prohibited FDI in entities that were engaged in the “inventory-based” model of ecommerce.
A marketplace model of ecommerce has been defined to mean one where an information technology platform is provided by an ecommerce entity to facilitate transactions between buyers and sellers (i.e., B2B). On the other hand, an inventory based model has been defined to mean one where goods and services are owned by the ecommerce entity and are sold by the ecommerce entity directly to the consumers (i.e., B2C).
Essentially, the Press Note bans any FDI in an entity that uses its online platform to sell products of a vendor which is either owned, or the inventory is controlled, by the entity that owns the online sales platform.
Subsequently, the government issued clarifications on 3 January stating that the Press Note was issued in light of complaints received that certain ecommerce entities that were purportedly carrying out their business under the marketplace model were indirectly engaging in an inventory based model and were, as a result, influencing the price of products on the marketplace platform. The changes proposed by the Press Note are meant to reinforce the prohibition on FDI in those ecommerce entities undertaking their business through an inventory based model and set out revised conditions to be complied with by entities operating on the marketplace model (Marketplace Entity).
The changes proposed by the Press Note are expected to come into effect on 1 February 2019. These changes are discussed below:
1. Control and Ownership of Inventory
A Marketplace Entity is not permitted to exercise ownership or control over the inventory sold by sellers on the marketplace platform. While the point relating to ownership of the inventory is clear enough, the Press Note clarifies that a Marketplace Entity will be deemed to “control” the inventory of a seller if more than 25% of such seller’s inventory is purchased from the Marketplace Entity or its group companies. Noncompliance with this requirement of control and ownership will render the model of business an inventory-based model, and hence an FDI restricted model of ecommerce.
The FDI Policy defines group companies to mean two or more enterprises which, directly or indirectly, are in a position to (a) exercise 26% or more of the voting rights of the other; or (b) appoint more than 50% of the members of the board of directors in the other enterprise.
2. Equity Holding in Sellers
A company in which a Marketplace Entity or its group companies have equity participation is not permitted to sell its products on the marketplace platform operated by the Marketplace Entity. The Press Note does not expressly state whether both direct and indirect equity participation is covered under this condition.
3. Fair Dealing with Sellers
A Marketplace Entity or any other entity in which the Marketplace Entity has direct or indirect equity participation or is under common control can provide services such as logistics, warehousing, marketing, payments, financing, etc. to sellers on the marketplace platform. However, such services must be provided on an arm’s length basis and on fair and non-discriminatory terms. Where such services are provided on dissimilar terms to sellers placed in similar circumstances, the provision of services will be deemed to be unfair and discriminatory. In case buyers on the marketplace platform are provided with cashback offers by group companies of the Marketplace Entity, such offers are to be given on fair and non-discriminatory terms.
4. Exclusive Arrangements with Sellers
A Marketplace Entity is prohibited from entering into exclusive arrangements with sellers to require them to sell their products exclusively on the marketplace platform. It appears that if a seller voluntarily chooses to sell its products exclusively on a marketplace platform, such arrangement may fall outside the scope of this restriction which appears to target exclusive arrangements dictated by Marketplace Entities. However, the Press Note does not provide any details on whether such voluntary arrangements are permissible.
5. Annual Reporting
Marketplace Entities are now required to submit a certificate together with a report by the statutory auditor confirming compliance with the guidelines on ecommerce activities set out in the FDI Policy to the Reserve Bank of India. The submission is to be made each year by 30 September for the preceding financial year.
The changes proposed by the Press Note, such as the one relating to control and ownership, will require certain existing Marketplace Entities to restructure their business operations. This may be a challenge given that compliance is required by 1 February 2019. According to recent news reports, certain Marketplace Entities have sought an extension of time to comply with the Press Note. However, there has been no formal communication by the government on extension of time for compliance.
In the absence of further guidance or clarification by the government on the proposed changes, the Press Note may temporarily stifle expansion plans or further investments by large international ecommerce companies that are currently operating in India. The Press Note may also have a much larger impact on FDI inflow as the amendments, including the timing of such amendments, could be viewed as creating an unstable regulatory environment in India.
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